Italy’s Debt Woes Roil World Markets

The yield on Italian bonds rose to a recent record this morning, signaling the distrust that investors have in Italy’s ability to repay its debts.

The Dow Jones industrial average was down 285.78, or 2.3%, to 11,884.40 in early trading. The broader Standard & Poor’s 500 index fell 2.7%, 34.50 points to 1,241.47.

Leading indexes in Europe were down 2.6% in France and 2.2% in Germany.

As investors fled European markets, they poured again into U.S. Treasury bonds, sending the yield on the 10-year Treasury bond below 2%. The dollar gained in value against the euro.

If you remember, Italy has been trying desperately to get its fiscal house in order. Prime Minister Silvio Berlusconi announced he would step down just after parliament passed a series of austerity measures. Also, just before he announced his plans to step down, Berlusconi agreed to oversight from the International Monetary Fund.

So what’s going on?

The AP reports that essentially the problems of Italy are being exacerbated by ballooning interest rates and are bigger than Berlusconi and will be tough for any parliament to deal with:

What happens in Italy is crucial to the eurozone’s survival. With debts of around euro1.9 trillion ($2.6 trillion), Italy’s debts are considered far too big for Europe to bail out.

Higher rates would make it more difficult and expensive for Italy to roll over its debts. The country has over euro300 billion ($412 billion) to raise in 2012 alone.

The Washington Post’s Ezra Klein puts it in terms we can identify with: “The problem, put simply, is that Italy is both too big to fail and too big to save.” He goes on to do some math about the world’s eight-largest economy:

At $2 trillion, it’s about seven times as large as Greece’s $300 billion economy. France and Germany’s banks alone have $600 billion in exposure to Italian debt. But Barclay’s says Italy is “now mathematically beyond the point of no return.” Silvio Berlusconi might be out, but changing governments does not change arithmetic. And so the question is simple, and stark: If there wasn’t the will to really save Greece, where would the will — and the money — come from to save Italy?

That’s what investors are weighing and that’s why the interest rate for Italian borrowing has shot up, beyond what The Wall Street Journal calls the “key” 7 percent level.” Essentially what it comes down to is can Italy afford to continue borrowing at those high rates to refinance its maturing debt? If it can’t, there may be no will — or enough money — from the European Union to rescue Italy and keep the Euro afloat.